“Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 per cent, which was likely to take some time,” the minutes, released on Wednesday, said, referring to the Fed’s inflation target.
The minutes also indicated that officials are attuned to how their policy communications are being digested by investors and others across Wall Street. In the weeks leading up to the December meeting, financial conditions had loosened as traders in fed funds futures wagered the Fed would back off its tightening campaign sooner than officials have signalled.
A slower pace of rate rises “was not an indication of any weakening of the committee’s resolve to achieve its price-stability goal or a judgment that inflation was already on a persistent downward path”, a number of participants said was important to make clear, according to the minutes.
Officials also warned an “unwarranted easing in financial conditions, especially if driven by a misperception by the public of the committee’s reaction function, would complicate the committee’s effort to restore price stability”.
According to the “dot plot” of policymakers’ interest rate projections published after the meeting, most officials now see the federal funds rate peaking between 5 per cent and 5.25 per cent, with a large cohort of the view that it may need to go even higher. That suggests a total of at least 0.75 percentage points’ worth of rate rises to come.
At the press conference that followed last month’s rate decision, Fed chairman Jay Powell warned that he could not “confidently” say the central bank would not raise its estimates again as he sought to push back against speculation that it would soon abandon its tightening plans.
“We’ve covered a lot of ground and the full effects of our rapid tightening so far are yet to be felt. We have more work to do,” he told reporters.
Michael Gapen, chief US economist at Bank of America, said the Fed could respond to the easing of financial conditions by raising interest rates more than expected and delivering a hawkish surprise to financial markets. The central bank next meets this month, with its rate decision announced in early February.
The minutes did not indicate whether officials are likely to support another half-point rate rise or shift down to a quarter-point increase, though the odds of the smaller jump stand at 70 per cent, according to CME Group.
However Gapen said he believes the Fed will press ahead with another half-point rate rise and warned there is a chance the central bank will eventually need to lift its policy rate to between 5.5 per cent and 6 per cent.
The dot plot showed that rate cuts are not expected until 2024, when the benchmark rate is projected to fall to 4.1 per cent, before dropping to 3.1 per cent in 2025. Growth is set to slow considerably as borrowing costs are kept high for an extended period, with most officials projecting an expansion of just 0.5 per cent this year before a 1.6 per cent rebound in 2024.
The unemployment rate is likely to increase by nearly a full percentage point from its current level to 4.6 per cent, the estimates show.
The minutes also indicated that officials are still chiefly concerned about “upside risks to the inflation outlook” and doing too little in terms of tightening. But there are also fears that the Fed will have raised rates excessively and to a degree that will lead to an “unnecessary reduction in economic activity”.
While the weakening economy is set to put downward pressure on prices, it is expected to take some time for inflation to fall to the Fed’s longstanding 2 per cent target. The central bank’s preferred inflation gauge — the core personal consumption expenditures price index — is projected to decline to 3.5 per cent by the end of 2023 and 2.5 per cent in 2024. As of November, it hovered at 4.7 per cent.
So far, the Fed’s tightening has been felt most in interest-rate sensitive sectors such as housing, where prices have declined dramatically from their coronavirus pandemic peaks. However, labour demand remains high as consumers continue to spend, helping to further entrench inflationary pressures that have taken hold across the services sector. Economists warn that rooting those out will require a recession and job losses.
Powell and his colleagues, as well as White House officials, maintain a recession can be avoided even as the unemployment rate ticks up.
© Financial Times
